Target These Underperformers in Asian 'Goldilocks' Phase

Key drivers of this 'just right' phase, and how to play it.

It is saying something that elections have been pulled off without a hitch in Thailand and Indonesia, and appear to be progressing in an orderly manner in India. Meanwhile, Britain's parliament remains an unruly rabble unable to make any decision whatsoever over Brexit. House Republicans appear happy to wing President Donald Trump over the Mueller report, then let his presidency flap along. As a Brit by birth, I can only say I'm very glad to be on the Asian side of the earth, right now.

Are Asian emerging markets hitting their "Goldilocks phase"? That's the theory posited by the global markets team at Nomura. They cite seven reasons for adopting a "don't worry, be happy" attitude to Asian equities.

First, the Fed appears to be turning dovish again. This tendency toward lower interest rates encourages investors to take more risk. The specter of a hard Brexit has also temporarily disappeared (until it surely returns) -- another reason for investors to be more confident.

Central banks in Australia, India, Korea and the Philippines also appear set to cut interest rates in the remainder of this year, with Indonesia following suit in 2020.

Nomura cites the positive outcomes of the India and Indonesia elections, too. Indonesian President Jokowi was reelected by an even bigger margin than in the last presidential election (an apparent 9.6% now to 6.3% in 2014). The early signs are that Indian Prime Minister Narendra Modi will also be reappointed to office. Both are business-friendly reformers pushing their economies to modernize, and funding those efforts.

The other factors are China-specific. Beijing is supporting the Chinese economy with easier credit. The latest economic figures have shown this is working, suggesting the Chinese economy has stopped decelerating. Add to that the likelihood of a U.S.-China trade deal in short order, and the Middle Kingdom appears well set.

The iShares MSCI All Country Asia ex-Japan ETF (AAXJ) would be one way to play this period of calm. It's up 14.8% so far this year, with a hefty 36% dose of Chinese stocks, and double-digit exposure to South Korea, Taiwan and Hong Kong.

That means it's running slightly ahead of the MSCI Emerging Markets Asia Index, which is up 14.0% in 2019. The iShares MSCI Emerging Markets Asia ETF (EEMA) tracks that. It is up 14.2% and excludes developed-Asia stocks in places like Hong Kong in favor of a slightly larger allocation to India, Thailand, Malaysia and Indonesia.

But China is the elephant in any Asian-market room. Tencent Holdings (TCEHY) and Alibaba Group Holding (BABA) combine for a 13% claim of the assets in EEMA, and China accounts for 40% of the allocation. At the same time, emerging markets may be coming into their own, this year's sudden fervor for Chinese stocks may be dying down.

The Shanghai and Shenzhen markets tend to lose their way a little bit in May. Sentiment for the Chinese equity markets turned better-than-average at the start of the year and peaked in March, according to separate Nomura research suggesting the "elation" in the mainland Chinese stock market is quietly winding down.

The global rally may in fact have been fueled by the sudden runup in Chinese stocks this year. But that, in turn, was driven by relief as a truce was called in the U.S.-China trade war. Other positive China-specific factors such as the apparent bottoming of the economy and the expansion of credit should now be priced in.

"Chinese equity market sentiment looks to have peaked ahead of that in the U.S. equity market," Nomura quant strategist Masanari Takada concludes.

If the stars are really aligning in favor of emerging markets, it may be time to turn to small-cap stocks. The SPDR S&P Emerging Small Cap ETF (EWX) is lagging global markets, up 11.1% in 2019, since small-cap stocks in emerging markets are generally viewed as the riskiest of risky propositions.

To avoid over-allocation to China, investors can find a very interesting niche play in the Nationwide Maximum Diversification Emerging Markets Core Equity ETF (MXDE) . It is not Asia-specific, although the continent makes up three-quarters of the allocation.

The broad diversification goal of the fund gives it large allocations to India (19%), China (13%), South Korea (12%), Taiwan (12%), Brazil (9%) and Thailand (8%), with a smattering of stocks from Malaysia and the Philippines, as well.

This fund is up only 7.4% in 2019, as investors flew to quality earlier in the year. Should the emerging-markets stars continue to shine, expect this fund to make up lost ground compared with global markets.

The Global X FTSE ASEAN 40 ETF (ASEA) is even more attractive for Asia addicts. Singapore, Thailand, Malaysia and Indonesia each make up more than 15% of that fund. It has shown very similar performance to the Nationwide fund, with the ASEAN product up 7.3% in 2019.

Both niche ETFs should gain ground, the last to rally in the global rebound we have seen this year. These are well worth watching for contrarian investors or those who do believe Goldilocks has come calling to taste the congee in emerging Asia.

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